Israel embarked on its first cycle of interest-rate hikes in more than a decade, raising borrowing costs more than forecast in response to above-target inflation and data showing an up-tick in wage increases.
The increase to 0.75% from 0.35% on Monday exceeded the estimates of most analysts surveyed by Bloomberg. In April, the central bank also delivered a bigger-than-expected hike of a quarter percentage point.
The Monetary Committee said in a statement that wages in the business sector were “slightly higher than the path that corresponds to the pre-pandemic trend,” suggesting that rising incomes had factored into its decision-making process. It reiterated that the process of raising rates will be “gradual.”
The Israeli shekel appreciated sharply after the decision and traded 0.7% stronger against the dollar as of 4:17 p.m. local time.
Consecutive rate increases are a rarity in Israel after years of subdued inflation that followed a period of historic appreciation for the shekel, among the world’s best-performing currencies since the 2009 global financial crisis.
This year, however, annual inflation has remained stubbornly above the government’s 1%-3% target range. It soared in April to 4%, a high last seen more than a decade ago.
Price growth is unlikely to peak for months, especially as global commodities costs come under more pressure from disruptions caused by coronavirus restrictions in China and the Russian invasion of Ukraine.
So far, Israel has enjoyed slower inflation than peers as gains in the shekel helped reduce the cost of imported goods and abundant supplies of domestic natural gas shielded the country from the surge in global energy prices.
But with Israel’s currency on track for its first decline in years, the central bank is looking to rein in inflation by relying more on changes to the benchmark rate, which has been at 0.25% or below since 2014. The Bank of Israel’s research department last month raised its 12-month rate forecast to 1.5% from close to zero.
“Inflation is, from meeting to meeting, becoming more concerning for the Bank of Israel,” said Alex Zabezhinsky, chief economist at Metiav Dash Investments Ltd, who predicted the bank would raise the base rate to 0.75%.
“I think inflation will be more important than other things — even growth,” he said in an interview after the decision was announced.
The central bank has made clear that Israel’s economic momentum is strong enough for it to focus on faster inflation.
Gross domestic product grew more than 8% last year, with unemployment continuing to decline toward pre-pandemic levels and the 12-month trailing budget deficit approaching balance. An unexpected GDP contraction last quarter was large part due to a technicality, skewed by surprisingly high growth at the end of 2021.
“The state of the economy is good enough and strong enough in Israel in order to enable interest-rate hikes,” Gil Bufman, chief economist at Bank Leumi, said before the decision on Monday.
Israel is also facing a cost-of-living crisis, with the country’s booming high tech sector, which employs around 10% of the population, helping push property prices out of reach for many people.
Since taking office last year, Israel’s coalition government has taken a number of steps to get a grip on prices, cutting taxes on fuel while boosting them for second homes, and reducing tariffs on a range of imported goods.
Despite strengthening after Monday’s decision, the shekel is still significantly weaker than it was last year, when it was responsible for as much as a third of Israel’s three percentage-point inflation gap with its peers, according to an estimate from Goldman Sachs Group Inc. The U.S. bank said the exchange rate is switching to become a “push factor” for price dynamics.
(c) 2022, Bloomberg · Daniel Avis
